Benefits of Economic Recession

It is so natural and obvious to hear the gloomy negative impacts of Economic Recession, but is there any positive outcome from such a gloomy thing as Recession, which is characterized by loss of jobs and loss of comforts.

To our surprise there is a positive side to Recession. Here are some of the Benefits of Recession:

The Housing Prices
The housing bubble, for one, should be looked at as an overall good thing for many people who were priced out of the market. In many parts of the U.S., homes were just flat out getting too expensive; now that they have dropped by double digit percentages in most areas, they are becoming more affordable. Obviously this isn’t necessarily a good thing for current homeowners, but it is certainly a correction that needed to be made.

Wake-up Call to Investors and Consumers
Another benefit of the economic recession is that it should serve as a wake-up call to investors and consumers alike. Things were going so well that many investors got big heads and took on a too much risk. Consumers on the other hand didn’t bother to save and instead decided to spend every penny they had and then some. The pain people are experiencing now as a result of those actions should be remembered next time a boom and bust comes around. This might be wishful thinking, as it seems people didn’t learn this lesson after the dot-com bust, but hopefully this time will be different.

Rethinking for Government Spending
In addition, this economic turbulence will force the government to re-evaluate their spending habits and overall budget.

Investors can buy assets cheap
Finally, one of the key benefits for investors from an economic recession is that they are often able to buy assets cheaply. Smart investors will look to capitalize on everyone else’s panic and desperation and buy up their assets at a hefty discount. Often times it is possible to actually make more money in a recession than during the boom. Less competition and desperate sellers mean lots of opportunity for investors. The trick is that investors need to make sure they aren’t buying assets which are going to decline in value.

What's the difference between a recession and a depression?

Recession
The standard newspaper definition of a recession is a decline in the Gross Domestic Product (GDP) for two or more consecutive quarters.

Depression
Before the Great Depression of the 1930s any downturn in economic activity was referred to as a depression. The term recession was developed in this period to differentiate periods like the 1930s from smaller economic declines that occurred in 1910 and 1913. This leads to the simple definition of a depression as a recession that lasts longer and has a larger decline in business activity.

Difference between a recession and a depression?
So how can we tell the difference between a recession and a depression? A good rule of thumb for determining the difference between a recession and a depression is to look at the changes in GNP. A depression is any economic downturn where real GDP declines by more than 10 percent. A recession is an economic downturn that is less severe.

Major Causes of the 2001 Recession

Introduction:

the American economy began to show signs of a slump at the beginning of the 21st century. In 2000 the so-called dot-com bubble—the explosion of companies that sprouted up to take advantage of the Internet—burst. Analysts cited many reasons for the failure of these companies. Among them was that investors overestimated the extent to which consumers were willing to buy goods and services online. When venture capitalists—the people and companies that provide money to start-up businesses—became reluctant to invest new funds, the collapse began.

As many Internet companies went out of business, the stock prices of once high-flying companies such as Cisco Systems, Inc., and Lucent Technologies began to plummet. Other large companies, such as Microsoft Corporation and AOL Time Warner, Inc. (present-day Time Warner Inc.), announced that they would not meet projected profits. And just as high-technology stocks fueled the market’s rise, they dragged the market down. Both the Dow Jones Industrial Average and The Nasdaq Stock Market ended 2000 with a loss.

Soon the rest of the economy started to weaken. The National Bureau of Economic Research, a respected group of economists, estimated that the U.S. economy actually stopped growing in March 2001. Manufacturing and employment began to decline. The big automobile companies shut down plants and laid off thousands of workers. As businesspeople traveled less, airlines began cutting back. By the end of 2001, corporate profits had suffered one of their steepest drops in decades.

Many economists believe that the terrorist attacks of September 11, 2001, made the country’s slumping economy even worse. After remaining closed for several days after the terrorist attacks, the stock market suffered a record plunge when it reopened, with anxious investors selling off their holdings. Companies continued to trim workers, accelerating a downsizing that would total more than 1 million jobs by the end of 2001. Unemployment reached 8.3 million in December 2001, the highest in seven years.

What caused the 2001 Recession?

The recession of 2001 had four causes.

1. First, there was the technology boom of the 1990s, which got carried to unsustainable speculative heights.
2. Second, there was a gush of money created by the Federal Reserve Fund which became channeled into higher asset prices (stocks and real estate) rather than the price of consumer goods.
3. Third was the fraud and abuse of corporations, stock brokers, mutual fund companies, and stock exchanges, a systematic corruption of the financial markets rather than merely isolated cases.
4. Fourth was the September 11 attacks, with its devastating losses, followed by the costly War on Terror.

What Happens during a Recession?

Recession -- Are we in:

Recession is a decline in economic activity within an economy, usually characterized by higher unemployment and less investment in new plants and equipment.

definition of recession - A period of general economic decline; specifically, a decline in GDP for two or more consecutive quarters.

In macroeconomics , a recession is a decline in a country's gross domestic product (GDP), or negative real economic growth , for two or more successive quarters of a year.

A severe or long recession is referred to as an economic depression. A devastating breakdown of an economy (essentially, a severe depression, or a hyperinflation, depending on the circumstances) is called an economic collapse.


Causes of Recession
recessions are caused by events that have an economy-wide impact, such as a

• decline in consumer confidence.
• increase in interest rates
• Firms reduce output and lay off workers, which further decreases demand, and the economy slows even more.
• Economic recessions can also be caused by events that would have an impact on specific companies or industries.

What Happens during a Recession?

• Stock market plummet
  People are generally conservative during recession. Those who lose their jobs because of recession start selling off their investments because they need money to sustain while they get another job. The increased number of people selling their stocks causes the stock market to fall sharply
  
• Real Estate Plummet
  During a recession, people turn to fiscal conservatism. This affects the real estate industry as well, as there is lesser demand in the real estate market. People put off buying and selling of property during the periods of economic recession.
  On the other hand, because of the higher supply of houses on sale as compared to the low demand, an economic recession will forcefully reduce the selling prices of homes. As such, the economic recession has a positive impact on potential homebuyers. This is also because there are lower mortgage rates that are caused by changes in interest rates.
  
• Rise of Unemployment Rate
  During a recession, there is a general trend of rising unemployment rates and decreasing overall output. With fewer people contributing to the economy, the overall economy is bound to be affected. Income growth would be stalled. While there would be more people in the market looking for employment, the demand for recruiting people is far lesser.

How Recession impacts you?

• You Investment portfolio shrinks
• Might lose your job
• Unable to pay your mortgage

Be prepared for Recession

• Have an Emergency Fund built up.
• Be a smart investor, revisiting your portfolio often.
• Create multiple sources of Income, dont just depend on your job.
• Learn to live within the means.
• Make some changes to your lifestyle and cut cost.

Be prepared and Be Recession Resistant.

Stocks

What Is a Stock?
Want to own part of a business without having to show up at its office every day? Or ever? Stock is the vehicle of choice for those who do. Dating back to the Dutch mutual stock corporations of the 16th century, the modern stock market exists as a way for entrepreneurs to finance businesses using money collected from investors. In return for ponying up the dough to finance the company, the investor becomes a part owner of the company. That ownership is represented by stock -- specialized financial "securities," or financial instruments -- that are "secured" by a claim on the assets and profits of a company.

Types of Stock
Common Stock. Common stock is aptly named, as it is the most common form of stock an investor will encounter. It is an ideal investment vehicle for individuals because anyone can own it; there are absolutely no restrictions on who can purchase it. Young, old, savvy, reckless -- heck, even professional mimes are allowed to own stock. [Editor's note: Complaints about this gratuitous and completely unnecessary shot at the fine profession of mime should be directed to the Association of Professional Mimes or, if you're really feeling ornery, the White House.] Common stock is more than just a piece of paper; it represents a proportional share of ownership in a company -- a stake in a real, living, breathing business. By owning stock -- the most amazing wealth-creation vehicle ever conceived (except for inheriting money from a relative you've never heard of) -- you are a part owner of a business.
Shareholders "own" a part of the assets of the company and part of the stream of cash those assets generate. As the company acquires more assets and the stream of cash it generates gets larger, the value of the business increases. This increase in the value of the business is what drives up the value of the stock in that business.

Because they own a part of the business, shareholders get one vote per share of stock to elect the board of directors. The board is a group of individuals who oversee major decisions made by the company. Far from being a perfunctory collection of do-nothings, the board wields a lot of power in corporate America. Boards decide how the money the company makes is spent. Decisions on whether a company will invest in itself, buy other companies, pay a dividend, or repurchase stock are all the purview of the board of directors. Top company management -- who the board hires and fires -- will give some advice, but in the end the board makes the final decision.

As with most things in life, the potential reward from owning stock in a growing business has some possible pitfalls. Shareholders also get a full share of the risk inherent in operating the business. If things go bad, their shares of stock may decrease in value -- or even end up being worthless if the company goes bankrupt. You will learn about selecting stocks -- or businesses -- in Step 6. Analyzing Stocks.

Different Classes of Stock. Occasionally, companies find it necessary for various reasons to concentrate the voting power of a company into a specific class of stock where the majority is owned by a certain set of people. For instance, if a family business needs to raise money by selling equity, sometimes they will create a second class of stock that they control that has 10 votes per share of stock and sell a class of stock that only has one vote per share to others. Does this sound like a bad deal? Many investors believe it is and routinely avoid companies where there are multiple classes of voting stock. This kind of structure is most common in media companies and has been around only since 1987.

When there is more than one kind of stock, they are often designated as Class A or Class B shares. On our Quotes & Data page, this is signified on the New York Stock Exchange and American Stock Exchange by a period and then a letter following the ticker symbol, a shorthand name for the company's shares that brokerages use to facilitate transactions. For instance, Berkshire Hathaway Class A shares trade as BRK.A, whereas Berkshire Class B shares trade as BRK.B. On the Nasdaq stock market, the class of stock becomes a fifth letter in the ticker symbol. For example, Bel Fuse trades under the tickers BELFA (the Class A shares) and BELFB (the Class B shares).

Other Types of Stock. You will learn about preferred stock and Real Estate Investment Trusts (REITs) in Step 5. Bonds.

How Stocks Trade
Probably one of the most confusing aspects of investing is understanding how stocks actually trade. Words such as "bid," "ask," "volume," and "spread" can be quite confusing.

Listed Exchange. The New York Stock Exchange (NYSE) and the American Stock Exchange (AMEX, composed of the Boston, Philadelphia, Chicago, and San Francisco Exchanges and now merged with the Nasdaq stock market) are both "listed" exchanges, meaning that brokerage firms contribute individuals known as "specialists" who are responsible for all of the trading in a specific stock. Volume, or the number of shares that trade on a given day, is counted by the specialist and reported to the exchange along with information on the price and size of each trade.
NYSE trades still take place face-to-face in the trading pit (yes, just like in the movies) where buyers and sellers physically converge on the specialist who matches buyers with sellers, but computers play a big part in the process these days. All trades are "auctions." There is no set price, although the last trade is often considered to be the "price" of a stock. In reality, the price is the highest amount any buyer is willing to pay at any given moment. When demand for a certain stock is high, the various buyers bid the price higher to induce sellers to sell. When demand for a stock is low, sellers must sell at lower prices to attract buyers and the price drops.

Over-the-Counter Market. The Nasdaq stock market, the Nasdaq SmallCap, and the OTC Bulletin Board are the three main over-the-counter markets. In an over-the-counter market, brokerages (also known as broker-dealers) act as "market makers" for various stocks. The brokerages interact over a centralized computer system managed by the Nasdaq.

Market makers may match up buyers and sellers directly, but mostly they maintain an inventory of shares to meet the demands of the market. So when you want to sell 100 shares of ABC stock, you don't have to wait for someone else to place an order to buy 100 shares of ABC; the market maker steps in, buys them from you immediately, then sells them when a buyer comes along. Market makers and specialists keep the markets "liquid" each in their own way. You are assured that, except in extraordinary circumstances, you can always buy or sell your shares if the market is open.

"Volume" numbers under the Nasdaq system are often inaccurate. Since most trades are in and out of the market makers accounts, what would be one trade on the NYSE (where buyers and sellers are matched directly) is usually two trades on the Nasdaq.

Investing Concepts

The Investment Process
What is investing? Any time you invest, you are putting something of yours into something else in order to achieve something greater. You can invest your weekends in a good cause, you can invest your intelligence in your job, or you can invest your time in a relationship. Just as you do each of these with the expectation that something good will come of it, when you invest your savings in a stock, bond, or mutual fund, you do so because you think its value will appreciate over time.

Investing money is putting that money into some form of "security" - a fancy word for anything that is "secured" by some assets. Stocks, bonds, mutual funds, certificates of deposit - all of these are types of securities. As with anything else, there are many different approaches to investing. Some of these you've probably seen on late-night TV. A well-dressed, wildly positive (though somewhat whiny) young man sits lazily waving palm fronds and shakes his head over how incredibly easy it is to amass vast wealth - in no time at all! Well, hey! That sounds fine! However, discerning minds will wonder: If it were so easy, wouldn't everyone who saw the same pitch be rich? Then, too, you always have to send some money to learn the secrets. So we suggest you take the $25 you'd spend on the hardcover EZ Secrets to Untold Billions book and the $500 you would shell out for the EZ Seminar, and invest it yourself - after you've learned the basics here.

Time Value of Money
Is a dollar always worth a dollar? OK, you sly fox - you caught us, it's a trick question! And you guessed it - a dollar is not always worth a dollar. Sometimes a dollar is only worth 80 cents, and sometimes it is worth $1.20. (Say! You give us your dollars worth $1.20, and we'll give you ours worth $0.80, in an even trade! Have we got a deal?)

But let's think about this. How can it be? The value of a dollar changes dramatically depending on when you can take control of the dollar and invest it. The critical variable in the exact value of a dollar is time.

If someone owes you a dollar, do you want him to pay you today or next year? (Yes! Another trick question! The answer is, "Today.") With inflation consistently destroying the purchasing power of a dollar, a year from now a dollar will be worth slightly less than it is today. "Inflation" is an economic term used to describe the gradual tendency of prices to rise over time. If inflation is 2% per year, that means that prices, on average, will rise 2% over the next year, which in turn means that your dollar can purchase 2 cents less in a year than it can today. That's right, all you mathematicians out there - with 2% inflation, a dollar today is worth only 98 cents in a year.

However, if you got the dollar back today, you could invest it. If you invested it (along with a few of its cousins, we hope) in the stock market, and your investment returned 10% over the course of the year (which is somewhat less than the market average has historically returned), then you'd have $1.10 at the end of the year. So your money would be growing instead of shrinking, and you'd be staving off the negative effects of inflation.

The Miracle of Compounding
In fact, if you leave this dollar invested, its value will mushroom over time through the miracle of compounding. As we discussed back in Step 1. Getting Started, as you earn investment returns, your returns begin to gain returns as well, allowing you to turn a measly dollar into thousands of dollars if you leave it invested long enough.

The more money you save and invest today, the more you'll have in the future. Real wealth, the stuff of dreams, is in fact created almost magically through the most mundane and commonplace principles: patience, time, and the power of compounding. To heck with your lousy odds in the lottery or with someone's "Wealth in Nanoseconds!" pitch.

Look at it another way -- if you were to take a mere $20 a week and put it into an index fund, then at the end of 40 years, assuming a modest 12% return, you would have just over a million bucks. In short, you would basically have won the lottery -- for $20 a week, or a total of $40,800 out-of-pocket along the way.

We like those odds.

Real Returns
Compounding is so miraculous that even at relatively low returns you can double and triple your money over long periods of time. When someone brags about doubling his money in 10 years, for instance, you shouldn't just smile and nod about how great he did. You only need a 7.1% annual return to double your money in 10 years. If the Standard and Poor's 500, a widely used barometer of the stock market, has gone up 10.6% a year, the poor fellow who doubled his money in ten years has actually underperformed the market. So now the trick becomes: In order to increase your money, how could you invest it so that it outperforms the market? (We'll learn more about finding good investments in Step 6. Analyzing Stocks.)

Now, let's say your investments earned 10% last year. How much did you really make? Well, the last time we checked the taxman wants to grab a piece of what you earn. One of the most significant factors investors tend to leave out when assessing their investment returns is the tax consequence. Even if you have a long-term capital gain that is only taxed at 20%, a 10% return quickly becomes 8%. And for short-term gains, the tax bite is even greater. At any rate, the question of importance for you is: "How much do I end up with at the end of the day?"

Another factor that affects returns, as we mentioned above, is inflation. So if your investments made 10% after taxes last year and inflation reduced your principal's buying power by 2%, then you actually only made a real return of 8%. All you need to do is to take your annualized after-tax return and subtract the annual rate of inflation. How can you find out what inflation was? Every quarter the government reports the Consumer Price Index (CPI), which is what most investors use as a proxy for general inflation at the consumer level. You can find it in your local newspaper's business section or at the Bureau of Labor Statistics.

Investing Versus Speculating
About now you may be sitting back thinking about your brother-in-law who "made a killing" in options. Or maybe you're reminiscing about that Nevada vacation when one lucky quarter magically drew out 700 more with the pull of a slot machine lever. Why put your money in slow-and-steady investment vehicles that merely promise double-digit returns when you could have near-instant riches? With compounding, you have to wait patiently for years for your riches to accumulate. What if you want it all now?

Granted, there is nothing exhilarating about predictability. Sure, tales of your fifth year beating the performance of the Standard and Poor's 500 Index won't make you the life of the party. However, neither will the far more common tales about how you lost your savings on some speculation, and your subsequent adventures in bankruptcy court. (Actually, that might make for some entertaining party chatter, especially given our penchant for reveling in the misery of others. But let's try for the moment to ignore sad musings about human nature.)

What are the odds of winning the lottery jackpot? Well, it depends on the lottery - they may be 1 in 7 million, or 1 in 18 million, or somewhere in between. You have a far greater chance of dying from flesh-eating bacteria - 1 in a million - than you do of winning that jackpot!

You don't need a card dealer, dour strangers, or Wayne Newton background muzak to gamble. There are plenty of stock market gamblers who do an admirable job of losing their money on seemingly legitimate pursuits. At the Motley Fool we think that commodities and options are just as risky as a Vegas craps game. In fact, we believe investors "gamble" every time they commit money to something they don't understand.

This, of course, may be true of stocks as well as of commodities and options. Say you overhear your best friend's dentist's nanny talking about a company called Huge Fruit at a cocktail party. "This thing is gonna go through the roof in the next few months," she says in a stage whisper. If you call your broker the first thing the next morning to place an order for 100 shares, you've just gambled. Do you know what Huge Fruit does? Are you familiar with its competition (Heavy Melon)? What were its earnings last quarter? There are a lot of questions you should ask about a company before you throw your hard-earned cash at a "hot" stock. There's nothing too hot about losing your money because you didn't take the time to understand what you were investing in.

Remember: Every dollar that you speculate with and lose is a dollar that is not working for you over the long-term to create wealth. Speculation promises to give you everything you want right now but rarely delivers; patience almost guarantees those goals down the road.

Planning and Setting Goals
Investing is like a long car trip. There's a lot of planning that goes into it.

How long is the trip? (What is your investing "time horizon"?)

What should you pack? (What type of investments will you make?)

How much gas will you need? (How much money will you need to reach your goals?)

Will you need to stop along the way? (Do you have short-term financial needs?)

How long do you plan on staying? (Will you need to live off the investment in later years?)
Running out of gas, stopping frequently to visit restrooms, and driving without sleep (this is the last of the travel analogy, we promise) can ruin your trip. So can saving too little money, investing erratically, or, as we said in Step One, doing nothing at all.

You must answer the following questions before you can successfully set about your savings/investing journey:

What are your goals? Is this money for retirement? A down payment on a house? Your child's education? A second home? Income to live on in the proverbial Golden Years?

How much money can you devote to a regular investing plan?

Don't let yourself get away with fuzzy answers, either. In the end, investing is a lot of numbers. You need to get used to that, and quickly. As a matter of fact, it can be quite liberating. You can see exactly what you need to get to your destination, and can be accountable to yourself along the way. Ask yourself some more pointed questions:

How much will college cost when my child needs to go?

How much yearly income is reasonable for retirement?
Don't worry ... you don't have to do all the math yourself. There are online interactive calculators available that can help you figure your future money needs. The more specific you can be, the more likely you are to set and achieve reasonable goals.

After you have a rough idea of how much money you'll need and how much time you have to get there, you can start to think about what investment vehicles might be right for you and what kind of returns you can reasonably expect.

Time Is on Your Side
To help put this into context, let's look at how various types of investments have performed historically. Bonds and stocks are the two major asset classes that have been used by investors over the past century. Knowing the total returns on each of these, and their associated volatility, is crucial to deciding where you should put your money.

Putting your money into cash reserves - U.S. Treasury bills, or more recently, money market funds - has yielded roughly 4.2% per year during this century, according to Global Financial Data. While this may not seem like a lot today, it is important to remember that for most of this century, inflation was nonexistent, making a 4.2% average annual return attractive until the 1960s. Though it is interesting that cash reserves have outperformed bonds this century, if one expands the time frame back to 1802, cash returns trail the return of bonds, and during the 1980s and 1990s, cash reserves have consistently trailed bond returns.

Long-term government bonds have returned around 4.0% per year since 1900; surprisingly, they're not that superior to short-term bonds. The best decade for bonds in the past century was the 1980s, when bonds returned 13.81% annually. The worst was the 1950s, when bonds lost -3.75%. Had you invested $1 in long-term bonds in 1900, you would have about $50 today.

Stocks have also been very good to investors. Overall, stocks have returned an average of 9.8% per year since 1900 - quite a bit higher than bonds. Surprisingly, the range of the returns for stocks is not that much larger than the range for bonds over the same period. According to Global Financial Data, the worst return in one decade was the 1930s, when stocks declined 0.17% per year, including dividends. The best decades have been the 1950s, when stocks increased by 18.23% annually; the 1980s, when stocks increased by 16.64% annually; and the 1990s, during which stocks have increased by 17.3% annually. Had you put $1 into stocks in 1900, you would have over $10,000 today.

Determining Your Investment Style
What kind of investor are you? Are you a swing-for-the-fences type, or are you content hitting singles and doubles, racking up slow and steady gains? Or do you prefer to sit in the stands, chatting with your companions and occasionally cheering your home team on?

Before you start investing, you should determine your investment style. There are two major variables in figuring out your investment style - your risk tolerance and the amount of time you can dedicate to investing.

Risk. How comfortable will you be if you invest in something in which the price changes every day - sometimes not the way you want it to change? There are various degrees of risk across the investment spectrum, from government bonds, which are considered risk-free as they are guaranteed by the government, to commodities and options, where you can and often do lose all of your money.
You need to consider how comfortable you will be seeing your investment decrease in the near term while you wait for it to increase over the long term. Although stocks have historically increased in price over the past two centuries, there have been some pretty bad periods. Without counting dividends, your equity investments could have lost almost 80% of their value had you bought stocks at the high in 1929 before the crash. You could have lost 40% had you bought at the high in 1972. Heck, in October of 1987 the Dow decreased 25% - in just one day! The important thing to remember about stocks, though, is that you don't lose anything until you sell them. For example, if you didn't panic and sell your stocks in October of 1987, you did quite nicely as the market rebounded in subsequent years. That's why, when you're investing in the stock market, you need to think long-term. Don't invest any money in stocks that you'll need in the short term.

Government bonds provide guaranteed returns, and bank savings accounts are insured by the Federal Deposit Insurance Corporation (FDIC). For stock investing, there is no similar guarantee or insurance that the ride will be smooth or that every investment will make you money, but if you buy good businesses and hold for the long term, the odds are in your favor. Just remember that the safest road isn't always the best one. At the Motley Fool we believe that the biggest risk is not taking enough risk, meaning not investing enough in stocks.

It should also be said that you can learn to increase your risk tolerance for investing in stocks. Once you see the kind of returns you can generate over time, you'll come to realize that it really doesn't matter if your stock drops or rises over the course of a few hours or days or weeks or even months. It may be fun to check your stock prices (and it's so easy on the Internet!) but it doesn't mean much over the long term.

Time. Speaking of the long term, time is another important element of your investing profile. How much time do you want to spend on investing? How active do you want to be in the management of your money? Do you want to spend 15 minutes a year on it? Then maybe you should consider using the Passive Strategies detailed below. Or maybe you have eight hours a week, in which case you might enjoy researching companies and poring over financial statements to pick individual stocks.

Another time factor is: When do you need the money? As we will discuss in Step 8. Keys to Success, whether you need the money next week or in a hundred years will dramatically affect what investment vehicle you decide to use. Although stocks have great long-term returns, the returns over periods of three years or less can be downright scary. Luckily for you, as you have now determined your goals and how much money you will need to get there, you also know how soon you will need the money and will be able to make the appropriate choices when you are ready to invest.

Active and Passive Strategies
The two main methods of investing in stocks are called active and passive management. No, active investors aren't the ones who exercise and eat leafy greens while passive investors watch too much TV and eat junk food. Instead, the distinction between active and passive investing is whether you (or whoever manages your money) actively choose the companies in which you invest or whether your investments are determined by some index created by a third party.

Active investing is what most people mean when they talk about stock investing. Whether they do it, their broker does it, or a mutual fund manager does it, the money is managed "actively." The hardest part about making the case for passive investing is convincing people that active investing may not always be all that it is cracked up to be. According to Lipper Analytical Services, over the five years ended in June 1998, 90% of "general equity" mutual funds, meaning garden variety stock funds, underperformed the Standard and Poor's 500 Index - the major benchmark for stock mutual funds.

With 9 out of 10 equity mutual funds failing to beat the market average over five years, you can understand why some people want an alternative to "active" management. Many people who just want a return equal to that of a major stock index use passive investing as a way to do this. The most famous passive investment strategy is investing in the Standard and Poor's 500 Index, also known as the S&P 500, although the Russell 2000, the Wilshire 5000, and various international indexes are also used for passive investment options.

Summary and Next Steps
Now you have figured out your goals, set your investment horizon, thought about your investment style, and considered whether or not to use active or passive investment strategies. You have come a long way from the tow-headed investment novice we met in Step One. At this point you may decide that investing in an S&P 500 Index mutual fund or the Dow Dividend Approach is the best investing course for you. But if you have aspirations of more actively managing your money or are curious about how doing so might improve your returns, please join us in Step 3. Stocks as we learn about stocks.

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